What Is Looked At in an M&A Valuation?

The business valuation in mergers and acquisitions process aims to put a dollar amount on a business by accounting for several factors and aspects of its operation. Two companies within the same niche that have the same market size may differ in valuation when you consider other aspects of business operation.

M&A Valuation Models to Know

While there are several valuation methods used to determine the worth of a business, appraisers typically choose one of these three M&A valuation methods:

Cost approach: The most straightforward approach, a cost$-$based valuation estimates what it would cost to replicate the business from scratch. This approach works best with businesses that are physical or tangible in nature. For example, you could gauge the cost of replicating an e$-$commerce business by summing the total of assets for the business.

Cost approaches to company valuations work less well for businesses that rely on intellectual capital. To give an example, it's difficult to objectively value an employee's talents or skills in a service$-$based businesses, so these companies are less likely to be valued with a cost approach.

Market approach: A market$-$based approach looks at similar business that sold recently to estimate the value of a company. This method is frequently used when there are other businesses, such as the seller's company in the same niche and geographic area. After all, a business that recently sold in another state or country does not provide useful data. This method isn't likely to be used with companies run by individuals or maverick companies in hybrid niches, since direct competitors are scarce.

Discounted cash flow approach: The discounted cash flow approach to a business valuation compares the potential future value of the business with its present$-$day cash flow perspective. If a business is projected to be worth a hefty sum in a given period $$ say, five years from now $$ an appraiser will work backward from the future valuation to determine its present$-$day worth. This estimate then becomes the company valuation now, even though the potential future income is hypothetical.

Understanding Which Factors Contribute to a Company Valuation in an M&A

After selecting the most relevant appraisal method, an appraiser will then look at these factors to come up with the valuation:

Assets: Adding the material worth of a company's assets and subtracting liabilities is a simple yet effective way to gauge value.

Earnings before interest, tax, depreciation & amortization $($EBITDA$)$: Taking EBITDA allows buyers to compare the seller's company with competitors by taking out these four factors.

Revenue multiple: This determines the value of a business proportionate to its revenue and can be used to determine whether the seller's company is $$cheap$$ or expensive to acquire.

Real option analysis: $$Real options$$ are simply asset$-$based choices, such as machinery or business property, rather than intangible assets such as IP$.$ Enticing or valuable real options can sweeten a deal.

P$/$E $($price earnings$)$ ratio: The ratio expresses a company's share price divided by after$-$tax profits and can help buyers and sellers compare a company to competitors.

Dividend yield: Similar to discounted cash flow, this gauge the present value of a future dividend to $$prove$$ worth.

Entry cost: The entry cost sums up the cost from scratch to start an equivalent business$$ it helps the buyer weigh the pros and cons of the M&A terms.

Precedent analysis: Comparable to the cost valuation method, this gauges the precedent price paid in similar M&A deals.

Question $3.(5$ Marks$)$

Evaluate the benefits that a company would gain from pursuing a merger, based on the discussion in the extract, with an example.